Do falling markets and tighter liquidity signal a new Great Depression?

This seems a surprising prospect at the moment, but according to Telegraph.co.uk this morning, Andrew Roberts, head of European rates strategy at RBS, said: “Great Depression II” could now be approaching; adding: “It now has the potential to speed toward its conclusion; a European $1 trillion package which does little and political panic tells you we are about to reach the end of the road. The world should be discussing deflation, not inflation.”

This apocalyptic view has been put forward as stock markets have fallen all over the world in the past couple of weeks. It seems that investors have been taking fright at the degree of ‘fiscal tightening’ taking place around the world. Also, there is the chance of a further liquidity crisis as some hedge funds are liquidating their positions in order to preserve capital.

Markets have also been responding to the euro crisis and the Greek debt debacle, and wondering whether the eurozone can actually survive in its present form. The recent collapse of the euro and its implications for trade, feature in an article today written by Grant Lewis, Head of Economic Research, at Daiwa Capital Markets Europe Limited. His article, entitled, “The weaker euro – who benefits” is reproduced below.

With the euro down almost 20% against the dollar since the Greek crisis blew up at the end of last year, European politicians seemingly doing their utmost to undermine the currency, and reports that fund managers are deserting the currency, a weaker euro looks here to stay. For many exporters based in the euro area, that will provide a welcome shot in the arm. But which economies will benefit the most from a weaker euro?

The chart above provides a rough guide to the relative importance of exports to the non-euro world for each participating member state. A few things stand out:

• Two small island economies – Ireland and Malta – stand to benefit greatly from a weaker euro (although, given the importance of the UK in their trade and the recent weakness of sterling, the chart probably exaggerates the boost from recent market events.)

• A middle ‘core’ group, which includes Germany, the Netherlands and Belgium, should also get a noticeable boost to economic growth from exports.

• But those countries at the eye of the fiscal storm in the euro area – Greece, Portugal and Spain – are the three countries that will benefit the least from a weaker currency. Italy, which has suffered from anaemic growth over recent years, and France, which has also repeatedly run current account deficits over each of the past five years, can also expect to receive little benefit from a softer euro.

Of course, a weak euro is not unambiguously good news for the euro area economy. For example, the resulting increase in import prices will hit real household incomes, which are already under pressure from pay cuts in public sectors, further dampening consumption growth. And it will do nothing to resolve the existing large imbalances within the euro area itself. Indeed, overall, we think that events in the forex market will simply exacerbate existing trends. The Germanic core will get a further boost to their ruthlessly efficient export sectors. But the crisis-hit and woefully uncompetitive Club Med countries, which were already faced with the poorest growth prospects, will get little or no benefit to demand.

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